A lot of times we hear in this market, analysts or traders talking about the pivot points, supports & resistances (in technical terms), so question arises what actually these are?
It is basically a level or point at which some some major movement is expected to occur.
Let us discuss in detail what actually these are & what is the significance of these levels.
A pivot point is a price level in technical analysis of a financial market that is used by traders as a predictive indicator of market movement.
A pivot point is calculated as an average of significant prices (high, low, close) from the performance of a market in the prior trading period.
If the market in the following period trades above the pivot point it is usually evaluated as a bullish sentiment, whereas trading below the pivot point is seen as bearish.
To calculate additional levels of support and resistance, below and above the pivot point, respectively, by subtracting or adding price differentials calculated from previous trading ranges of the market.
Several methods exist for calculating the pivot point (P) of a market. Most commonly, it is the arithmetic average of the high (H), low (L), and closing (C) prices of the market in the prior trading period:
P = (H + L + C) / 3.
Sometimes, the average also includes the previous period's or the current period's opening price (O): P = (O + H + L + C) / 4.
In other cases, traders like to emphasize the closing price, P = (H + L + C + C) / 4,
or the current periods opening price, P = (H + L + O + O) / 4.
Support and resistance levels:
Price support and resistance levels are key trading tools in any market. Their roles may be interchangeable, depending on whether the price level is approached in an up-trending or a down-trending market. These price levels may be derived from many market assumptions and conventions. In pivot point analysis, several levels, usually three, are commonly recognized below and above the pivot point.
These are calculated from the range of price movement in the previous trading period, added to the pivot point for resistances and subtracted from it for support levels
The first and most significant level of support (S 1) and resistance (R 1) is obtained by recognition of the upper and the lower halves of the prior trading range, defined by the trading above the pivot point (H − P), and below it (P − L). The first resistance on the up-side of the market is given by the lower width of prior trading added to the pivot point price and the first support on the down-side is the width of the upper part of the prior trading range below the pivot point.
• R1 = P + (P − L) = 2×P − L
• S 1 = P − (H − P) = 2×P − H
Thus, these levels may simply be calculated by subtracting the previous low (L) and high (H) price, respectively, from twice the pivot point value:
The second set of resistance (R 2) and support (S 2) levels are above and below, respectively, the first set. They are simply determined from the full width of the prior trading range (H − L), added to and subtracted from the pivot point, respectively:
• R2 = P + (H − L)
• S 2 = P − (H − L)
Commonly a third set is also calculated, again representing another higher resistance level (R 3 ) and a yet lower support level (S 3 ). The method of the second set is continued by doubling the range added and subtracted from the pivot point:
• R3 = P + 2× (H − L)
• S 3 = P − 2× (H − L)
This concept is sometimes, rarely, extended to a fourth set in which the tripled value of the trading range is used in the calculation. Qualitatively, the second and higher support and resistance levels are always located symmetrically around the pivot point, whereas this is not the case for the first levels.
The pivot point itself represents a level of highest resistance or support, depending on the overall market condition. If the market is directionless (undecided), prices will often fluctuate greatly around this level until a price breakout develops. Trading above or below the pivot point indicates the overall market sentiment. It is a leading indicator providing advanced signaling of potentially new market highs or lows within a given time frame.
The support and resistance levels calculated from the pivot point and the previous market width may be used as exit points of trades, but are rarely used as entry signals.
For example, if the market is up-trending and breaks through the pivot point, the first resistance level is often a good target to close a position, as the probability of resistance and reversal increases greatly.